Understanding Business Ownership Structures: Operating Company, Holding Company, and Family Trust

Do you know how many business owners are unaware of the different roles in operating a company, holding a company, and a Family Trust play in their corporate structure? Hi, I’m Dave, and I help make Canadian business owners’ goals a reality with innovative financial advice. In this article, we will delve into the intricacies of these entities, their purposes, and the benefits they offer to business owners. Let’s explore the world of operating companies, holding companies, and Family Trusts.

Operating Company: The Foundation of Your Business

The operating company is the backbone of your business. It handles day-to-day operations, generates revenue, manages employees, and keeps your business running smoothly. One significant advantage of an operating company is the separation it provides between your personal and business assets, offering protection against personal liability in case of legal issues.

Holding Company: Maximizing Benefits

A holding company, on the other hand, is a separate entity that can own various assets, including real estate, stocks, and other investments. It can also own the operating company. Holding companies offer a range of benefits, such as tax advantages, liquidation benefits, creditor and asset protection, and streamlined estate planning.

Family Trust: Safeguarding Assets for Generations

A Family Trust is a legal entity that holds assets for the family, similar to a holding company. It can own the operating company and designate the holding company as a beneficiary. This arrangement offers protection against creditors, lawsuits, and legal issues. It’s especially valuable if you plan to sell your operating company in the future, as we’ll explore shortly.

Determining Your Needs

Now that you’re familiar with these entities, you may wonder which ones you need. The first step is to establish an operating company, a necessity for every incorporated business owner. If your operating company generates profits beyond your expenses, it’s time to consider a holding company.

The Power of Holding Companies

Holding companies provide significant advantages, including tax savings. They allow you to transfer retained earnings from the operating company as tax-free dividends, granting you flexibility in managing your income and reducing your tax liability. This strategy is particularly beneficial if you’re in a high tax bracket.

Additionally, holding companies offer creditor and asset protection, simplifying the process of qualifying for the lifetime capital gains exemption when selling shares of your small business. This exemption can result in substantial tax savings during the sale of your business.

Unlocking Additional Value with a Family Trust

While operating and holding companies suffice for many business owners, a Family Trust can bring added benefits, especially if you plan to sell your business for a substantial sum. The Family Trust structure allows you to leverage multiple lifetime capital gains exemptions, potentially saving you millions in taxes.

For instance, if you, your spouse, and your children are beneficiaries of the Family Trust, you could collectively benefit from exemptions exceeding $4.8 million from the sale of your business. To qualify for this strategy, certain criteria must be met, including holding shares in the trust for a minimum of 24 months.

Timing Matters

Lastly, when should you set up these entities? While it’s hard to predict your business’s profitability from day one, it’s wise to consider establishing a holding company and a Family Trust early in your corporate journey. This proactive approach can save you time and expenses compared to retrofitting your structure later.

Each of these entities serves distinct purposes and offers unique advantages. With a clear understanding of their roles and benefits, you can optimize your corporate structure to align with your financial goals.